Chapter 5: Monitoring Jobs and Inflation
• The labor market
– Measurement of unemployment, labor force
participation, employment-population ratio.
– Shortcomings of unemployment rate as measure of
labor market performance
– Statistics describing U.S. labor market
• Prices
– Why inflation is a problem
– Measuring the price level: the consumer price
index
– Shortcomings of CPI
Unemployment
• Why is unemployment a problem?
– Lost production and income
– Lost human capital
• Measuring unemployment
– The Current Population Survey
•
•
•
•
Monthly survey
Approximately 60,000 households
Used to monitor employment, hours wages
Primary source of data for unemployment rates
Labor Force Measures: 4th quarter, 2009
U.S. population: 308.5 million
Civilian Non-institutionalized Working age
(16+) population: 236.7 m.
Out of labor
force
In Labor Force
153.5 m.
83.2 m.
Employed
Unemployed
138.1
15.4
Not in Civilian NonInstitutionalized Population
71.8 m.
Labor market definitions
• Civilian Non-institutionalized Working Age
Population
– Excludes military and institutionalized
– Working age is 16+
• Unemployed
– Without work but has made specific efforts to find a
job within the previous four weeks
– Waiting to be called back to a job from which he or
she has been laid off
– Waiting to start a new job within 30 days
Labor market statistics
unemployed
unemployment rate 
civilianlaborforce
civilianlaborforce
laborforce participation rate 
civiliannoninstitu
tionalizedworkingage population
employed
employment- populationratio 
civiliannoninstitu
tionalizedworkingage population
Which is more cyclical – participation rate or employment ratio? Why?
Unemployment as a measure of labor
utilization.
• Imperfect measure because
– Excludes some underutilized
• Underemployed
– e.g. part-time workers who want full-time work
• Discouraged workers
– People who want jobs but quit searching due to lack of job
opportunities
– Some unemployment is “natural”
• Even when economy is operating at capacity, there are new
entrants who must search for jobs
• In 2008, more than 3 million new workers entered the labor
force and more than 2.5 million workers retired in U.S.
economy.
Sources of Unemployment
People become unemployed if they
1. Lose their jobs and search for another job.
2. Leave their jobs and search for another job.
3. Enter or reenter the labor force to search for a
job.
People end a spell of unemployment if they
1. Are hired or recalled.
2. Withdraw from the labor force.
•All are counter-cyclical, but job losers is most sensitive to business cycle.
Types of Unemployment
• Frictional
– unemployment that arises from normal labor market
turnover (entry, re-entry, etc.)
– Affected by UI generosity, demographics
• Structural
– unemployment created by changes in technology and
foreign competition that change the skills needed to
perform jobs or the locations of jobs
• Cyclical
– Fluctuating unemployment over the business cycle
– Temporary loss of jobs associated with a recession
Natural Rate of Unemployment
• The unemployment rate when the economy
– is at “full employment”
– has only frictional and structural unemployment, no
cyclical unemployment
• Natural unemployment rate in 1980s was thought
to be around 6%; thought to be around 5% in
1990s and 2000s.
– Decline in natural rate due to changing demographics
• Baby boom
• Entry of women into labor market
Real GDP and Unemployment
• Potential GDP is the quantity of real GDP
produced
– when the economy is at full employment
– When the unemployment rate equals the natural
rate
• Output Gap = Real GDP – Potential GDP
Inflation
• Price level
–average of the prices that people pay for all
the goods and services that they buy.
•Inflation rate
–percentage change in the price level between
time periods.
•Inflation
–occurs when the price level is rising persistently.
•Deflation
–occurs when inflation is negative and prices are
falling persistently
Why inflation is a problem
• Redistributes income and wealth
– Borrowers and lenders
– Employers and workers
– Taxes that are not indexed for inflation
• Diverts resources from production
– Inflation forecasting becomes more important
– Negotiate shorter contracts more frequently
– May lead to “barter” if inflation rises to
sufficiently high levels (hyperinflation)
Measuring the price level and inflation
• Consumer Price Index (CPI)
– measures the average of the prices paid by urban
consumers for a “fixed” basket of consumer goods
and services.
– defined to equal 100 for the reference or base
period.
– Using 1982-84 as the base year,
• the CPI in December 2009 was 216
• prices in December 2009 were 116 percent higher than
in 1982-84.
Constructing the CPI
• Selecting the
basket
– Based on
Consumer
Expenditure
Survey of
2001-02
– Basket
contains
80,000 goods
Constructing the CPI
• The monthly price survey
– Every month, BLS employees check the prices of
80,000 goods in 30 metropolitan areas
• Calculating the CPI
1. Find the cost of the CPI basket at base-period prices.
2. Find the cost of the CPI basket at current-period
prices.
3. CPI in t = Cost of bundle at current prices in t X 100
Cost of bundle at base year prices
Base year = 2008
CPI in 2008 = (70/70)*100
=100
(CPI in base year always equals
100
CPI in 2009 = (70/50)*100
=140
Inflation rate between 2008 & 09
• percentage change in CPI
•(140-100)/100 = 40%
The Price Level: 1982-84=100
The Inflation Rate
Biases in CPI
The CPI might overstate the true inflation for four
reasons:
• New goods bias
• Quality change bias
• Commodity substitution bias
• Outlet substitution bias
Consequences of bias in CPI
• Increases government spending too quickly
– Social Security, Disability, etc.
– Approximately 1/3 of federal spending tied to CPI
• Causes tax revenue to rise too slowly
– Income tax code is tied to CPI
• Creates downward bias in estimate of real
earnings growth
• Distorts private contracts tied to CPI
– Union COLA’s
Other price indexes
• CPI for different types of consumers
– Urban consumers
– Urban workers
– Different regions, states, metro areas
• CPI for specific commodity groups
• Core CPI
– Excludes food and energy
• GDP deflator (covered earlier)
– Covers prices of all goods & services produced, not
just what consumers purchase.
Adjusting for Inflation:
Nominal vs. Real Variables
Real Variable in t = Nominal Variable in t X 100
Price Index in t
Price index could be CPI or GDP deflator
e.g. If Nominal Wage in 2010 is $20 and CPI is 200,
Real Wage in 2010 is
Real variable
–Adjusts nominal values to reflect prices in base year.